SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

The Value of Equity Asset Class Diversification


This investing lesson is a tale of two time periods that highlight the important role of equity asset class diversification and systematic rebalancing in an equity fund portfolio.  Human nature is a failed investor, when our natural instinct is often to do the exact opposite of what we should do in practice.

The important point is that these lessons are simple and can be systematized so that in real-time you can simply follow your well-designed plan without having to interject human judgement which is often heavily influenced by emotion and short-term performance.


For example, below are the net returns of four funds representing four distinct equity asset classes from 1995-1999. This example is meant for illustrative purposes only, and past performance doesn’t guarantee future results.
 

image.png 


Notice the stark differences in performance during this time period. US equities dominated both International and Emerging Markets, especially US Large Cap compared to International Small Cap Value. Considering that the average investor instinctively thinks five years is a long enough period of time to evaluate performance, what do you think he or she might feel like doing at this point? Certainly not rebalance the portfolio back to its original weighting by selling a material amount of SPY to buy DISVX. That would feel backwards, but it’s an important part of successful long-term investing. Let’s now look at the next decade, from 2000-2009, to see why.
 

image.png

 

What a contrast. From 2000-2009, US Large Cap actually produced a loss and International Small Cap Value produced the largest gain. Since most investors are over concentrated in US Large Caps, it explains why this period is referred to as “The Lost Decade.” This clearly wasn’t true of all stocks in the US or the rest of the world as we can see. Investors who abandoned diversification in 1999 would have experienced a lot of pain in the 2000’s, while the average of the four asset classes was more than double the starting value. Let’s now put the entire 1995-2009 period in context and also highlight the power of rebalancing.
 

image.png

 

During this entire period, we see all four asset classes produced strong results with the average growth of $100,000 being $369,560. In other words, if an investor put $25,000 into each fund in 1995 and did absolutely nothing, the investment would have been worth $369,560 at the end of 2009. This is a compounded annual return of 9.11%, which highlights the power of equity investing. Yet you’ve probably noticed I’ve added one additional line item to highlight the benefits of rebalancing a portfolio.
 

The rebalancing rule is as follows: Each month, review if any of the funds have drifted by a relative 25% from their target weightings. Since we are targeting 25% in each fund in this simple illustrative example, that means you would rebalance anytime a fund has drifted by more than 6.25% from the target 25% allocation. In other words, as long as each fund’s current weight is between 18.75% and 31.25%, you do nothing. During this period of 1995-2009, you would have rebalanced only eight times.

But as we can see, rebalancing would have added more than $45,000 to the portfolio, increasing the compounded annual return to 9.95%! This is more of a “rebalancing premium” than we should expect over the long term, which is no surprise since I intentionally picked funds and a time period for this article to emphasize a point. Vanguard has expressed in its “advisor’s alpha” concept that a good advisor can add “about 3% per year” of value to a client’s situation of which 0.35% per year is estimated to come from disciplined rebalancing. This rebalancing premium is intuitive when we stop and think about it, as it forces us to “buy low/sell high.
 

Conclusion

 

Human nature is a failed investor, and the best way to overcome the most common investor mistakes is with a well thought out evidence-based plan that incorporates the important concepts of equity asset class diversification and disciplined rebalancing. Working with a financial advisor who intimately understands these concepts can help improve the odds of a successful long-term investment experience.

 

Jesse Blom is a licensed investment advisor and Vice President of Lorintine Capital, LP. He provides investment advice to clients all over the United States and around the world. Jesse has been in financial services since 2008 and is a CERTIFIED FINANCIAL PLANNER™ professional. Working with a CFP® professional represents the highest standard of financial planning advice. Jesse has a Bachelor of Science in Finance from Oral Roberts University. Jesse manages the Steady Momentum service, and regularly incorporates options into client portfolios.


Related articles

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Try It Free

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • The Big Loss

    At his blog, Joey offers his perspective on the top reason that so many trader wannabes are not, and will not, become profitable traders. His post is titled: Learn to Lose Money to Make Money. Here are the Excerpts from the blog.

    By Mark Wolfinger,

    • 0 comments
    • 260 views
  • ETF Vs. Stock: Note Down the Vital Points

    Today’s small investment can fulfill your dream of high living tomorrow. But investing blindly can make it reverse. We all want to get a high return on our investment. Stocks or ETFs can be the best option for you in such cases. The investment in stocks or ETFs is not very different except few noticeable points.

    By Kim,

    • 0 comments
    • 292 views
  • Considering Trading? Here Are Some Trading Options You Need To Know

    Whether you are considering dabbling in day trading or looking for a longer-term investment if you want to start trading it will serve you well to carry out a little due diligence in advance. There are a number of markets that you could use and understanding how each one works and what they are all about is key.

    By Kim,

    • 0 comments
    • 5,873 views
  • Why Should You Paper Trade Options

    In my previous article I shared some thoughts why I believe traders should start with paper trading before committing real capital. Not everyone would agree, but today I would like to share another article by a trader I respect very much. The original article was published here

    By Kim,

    • 0 comments
    • 295 views
  • Is Long Call Better than Bull Credit Put Spread?

    The trigger to this article was a question posted on the forum: "why we should use bull credit put spread when you can just long call they both have limited loss both in long call you have unlimited profit why limited it with bull put spread?" You can read the discussion here.

    By Kim,

    • 0 comments
    • 446 views
  • Strike Selection: A 'Sweet Spot' for Option Sellers?

    The words above are powerful because they're approach-agnostic. It doesn't matter if you're an old-school pit trader who swigs grit instead of coffee before the opening bell, or a Gen Y technocrat who codes trend-detection algorithms. All traders live and die by The Four Words. If you consistently buy low and sell high, then you will be profitable.

    By Kim,

    • 0 comments
    • 1,558 views
  • Post-Earnings Implied Volatility Crush

    Earnings crush is the fall in implied volatility after earnings is announced. Typically, earnings announcements cause the price of the stock to move more than normal. The move will have more effect on short dated expirations since the day of earnings large move has more weight than the rest of the days with normal moves. 

    By ORATS_Matt,

    • 0 comments
    • 352 views
  • Why Not to Hold Strangles Through Earnings

    In my previous article, I described a strategy of buying strangles a few days before earnings and selling them just before earnings. In this article, I will show why it might be not a good idea to keep those strangles through earnings.

    By Kim,

    • 0 comments
    • 387 views
  • How to Prepare for Crypto Downturns

    Most cryptocurrency owners skipped a heartbeat when the bitcoin fell to 50% from its all-time high. According to experts, such nasty downturns are natural, and the crypto market may witness such downturns now and then.

    By Kim,

    • 0 comments
    • 520 views
  • Tradier Brokerage Special Offer

    Tradier Brokerage is partnering with SteadyOptions to offer a special promotion for SteadyOptions customers: Open an account with Tradier Brokerage and get no subscription fees for 3 months, plus all ACAT fees will be waived. After opening an account, you will also receive 3 months of free access to TradeHawk, our full-featured customizable trading platform.

    By Kim,

    • 0 comments
    • 662 views

  Report Article

We want to hear from you!


There are no comments to display.



Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account. It's easy and free!


Register a new account

Sign in

Already have an account? Sign in here.


Sign In Now

Options Trading Blogs Expertido